Who's Running the Fed?

The news media reported Wednesday that Fed Chairman Ben Bernanke had
spoken on the phone with former Treasury Secretary Robert Rubin after
the Fed's decision to keep interest rates unchanged in August. Mr.
Bernanke also had conversations with Lewis Ranieri, founder of Hyperion
Capital Management, and Raymond Dalio, president of Bridgewater
Associates.

Mr. Rubin had a long career at Goldman Sachs and is
now chairman of the executive committee and a director of Citigroup.
Mr. Ranieri, according to Bloomberg News, is a former vice-chairman of
Salomon Brothers (now part of Citigroup) and is 'a pioneer in the
mortgage-backed securities market'. Bridgewater is the fourth largest
US hedge fund with assets under management of $32 billion, according to
HedgeFund Intelligence's Absolute Return magazine.

Subsequent to
these discussions, the Fed reversed its inflation-fighting stance and
made aggressive interest rate cuts in September. It does not take a
huge stretch of the imagination to speculate that Mr. Bernanke was more
than a little influenced by his Wall Street contacts. His discussions
with bankers and investors probably emphasized the near-term benefits
of cutting rates, and likely downplayed the longer-term damage of moral
hazard and lost credibility. These conversations were more likely to
highlight the imminent risk of a credit crunch and the need for urgent
intervention, and less likely to voice concern on the state of the US
dollar and the emergence of inflationary pressures.

The power
centers of Wall Street, big banks and hedge funds, now run the Federal
Reserve because there are now too many large banks and too many large
hedge funds that are too big to fail. It was relatively easy to deal
with one LTCM collapse in 1998. Imagine a dozen LTCMs taking place at
the same time. One major failure could cascade through the system and
have catastrophic consequences. How did we get here? Perhaps the repeal
of Glass-Steagall and the explosive growth of unregulated hedge funds
are a good explanation. None of this is a good omen for the future.